The performance of Croatia’s different real estate markets will probably continue to diverge in 2008. Demand from EU buyers for properties near the Adriatic Coast is expected to continue strong as Croatia is expected to join the EU in 2010.

House price growth in Zagreb and the rest of Croatia is likely to stagnate, due to tighter monetary conditions and higher inflation.

Foreign demand

Real estate is more actively traded in the Adriatic coastal areas and other popular tourist destinations. The Northern peninsula of Istria is home to a property boom fuelled by German buying.

Around 55% of approved permits for foreign acquisitions were granted to Germans. Austrians come in second place with 16% of permits granted, followed by Britons (6%), Hungarians (4%) and Dutch (3%).

Out of the 20 counties of Croatia, the five most popular counties for foreign buyers are all along the Adriatic Coast: Istria (33% of foreign-owned properties), Primorje-Gorski Kotar (26%), Split-Dalmatia (12%), Zadar (8%), and Dubrokniv-Neretva (6%). Only 3% of foreign buyers chose Zagreb City.

The restrictions on foreign ownership are expected to be relaxed in two years’ time, as EU accession is expected in 2010.

House price boom

2007 was an exceptional year in the Croatian housing markets. The average price of newly built dwellings in Croatia surged 26% to 11,252 Croatian Kuna (HRK) (€1,563) per sq. m. from HRK 8,939 (€1,242) in 2006. When adjusted for inflation, house prices rose 22.3% over the same period, according to Croatian Bureau of Statistics.

This was in sharp contrast to 0.7% (3.9% in real terms) drop in house prices in 2005, and the negligible 0.3% increase in 2006 (2.8% drop in real terms).

While housing demand and supply has been constantly increasing since 2001, the erratic movement of house prices can probably be attributed to changes in speculative demand. Wealthy Croatians traditionally park their wealth in housing in times of uncertainty. For instance, when the economy started to weaken in late 1998, demand for new housing increased substantially. The average price of new houses rose by almost 20% in 1999 - the year of President Fradjo Tudjman’s death - while the economy contracted 0.8%.

Housing supply

From 1981 to 1990, around 20,000-30,000 dwellings were constructed annually in Croatia, then still part of Yugoslavia. During the War of Independence (1991-1995), dwelling completions dropped to less than 10,000 annually. The war also left a significant amount of the dwelling stock damaged.

The post-war period was equally challenging. The shift from socialism to a market economy saw much privatization in favour of authoritarian President Fradjo Tudjman’s cronies. Although annual dwelling construction increased to an average of 12,787 units from 1996 to 1999, this was still insufficient.

Tudjman’s death in December 1999 and the subsequent election of a new government led to substantial reforms in the economy. With the sudden increase in house prices in 1999, housing construction surged in 2000 to 17,487 dwellings completed. Around 18,000 dwellings were completed annually from 2002 to 2005. Improved economic conditions combined with changes in ownership laws, zoning restrictions and building regulations then led to a further increase in construction activity. In 2006, more than 22,000 dwelling were completed.

Launched in 2001, the Socially-Supported Government Housing Construction (POS) Programme, has added to the stock of relatively cheap housing. Flats were sold under the programme at a maximum price of €910 per sq. m., much lower than the average market price in 2001 of approximately €1,400. By end of May 2005, a total of 2,006 flats had been completed and sold under the POS programme.

Housing demand

Recovering from the 1999 political and economic crises, the economy started to gain momentum in 2000. From 2001 to 2006, average annual GDP growth was 4.8%. In 2007, the economy grew by 5.75%. Real GDP per capita rose 38% from 2000 to 2007, while unemployment dropped from 16% in 2000 to 9.6% in 2007.

The return of the individuals displaced by the war added to demand. From the beginning of the return process in 1995 the number of registered returnees had reached 338,618 by 2005; 218,478 of these returnees were Croatians, while the remaining 120,140 were ethnic Serbs.

From 1995 to 2006, no less than 19,262 houses were repossessed to house returnees. The interim occupants were re-housed either in dwellings purchased by the Government Real Estate Agency (APN), or received construction materials to build homes, or were accommodated in state-owned apartments.

With regards to housing of ex-tenancy right holders, the plan is for APN to purchase and refurbish apartments currently available in the market as well as to construct a significant number of new apartments. Inside the area for special state concern (ASSC), a total of 1,440 families of ex-tenancy right holders have been provided with reconstructed houses as of 2003.

Mortgage market growth

The housing finance market has seen significant development. The old large state-owned banks have been privatized, and commercial banks have been restructured. Austrian, Italian and German banks have entered the market, leading to better capitalization and more competition.

As a result, housing loans expanded from HKR 8.3 billion in 2000 (€1.16 billlion), to HKR 47.77 billion in 2007 (€6.64 billion); from 5.45% of GDP in 2000 to 17.3% in 2007. From 2002 to 2007, outstanding housing loans grew by an average of 31% annually.

The establishment of building societies since 1998 has helped. By end-2007, five building societies were operating. Government premiums have enabled building societies to offer cheaper home loans than the commercial banks.

Though commercial banks still dominate the housing finance market, the building societies’ share of total loans has increased from 1% in 2003, to 4.65% in 2007.

Low interest rates have contributed to housing credit growth. Most loans in Croatia are variable rate mortgages indexed to the euro (previously to the deutschemark) or Swiss Francs.

Mortgage interest rates dropped from an average of 7.76% in 2002, to 4.81% in 2006. Despite the interest hikes implemented by the European Central Bank (ECB), interest rates on housing credits are still relatively conducive to borrowing, at 5.85% in June 2008.

Housing market prospects

Inflation reached 7.56% in June 2008, the highest recorded inflation rate since 1995. Annual average inflation from 2001 to 2007 was only 2.67%. Fearing financial instability, the Croatian National Bank limited lending growth to 12% per annum. Combined with rising interest rates, this is expected to further slow the market.